The Psychology of Investing

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I’m no therapist, but I know money, and it’s really interesting that we can look at people’s behavior patterns and see pretty clearly that psychology plays no small role in people’s investment decisions. The danger is that it can lead to severe missteps that end up costing people countless dollars.

How does that happen? Do you have an example?
The most common mistake we see when people allow their heads to rule their pocketbooks is giving into FEAR. Fear is without question the primary culprit when it comes to emotions getting in the way of sound financial decisions.

Can you elaborate on that a little?
Absolutely. A certain degree of what psychologists call “risk aversion” is good. It’s risky to jump off a cliff, so most people choose not to do it and avoid serious injury. That’s true of money decisions as well: It’s risky to put your entire retirement nest egg into one stock. Just like in life, a healthy amount of trepidation is wise when it comes to managing your money.

Unfortunately, what we see more often is people overwrought with fear. No one wants to lose their money—it’s a very scary prospect—so a common mistake is to play to too safe. The irony is that you end up LOSING money if you play it too safe.

How do you mean?
The national average on savings accounts is about 0.2% right now. Zero point two! That is NOTHING. You may as well pay the bank to keep your money there, because that’s basically what you’re doing. Inflation is about 2% right now, but historically it’s around 3%. Either way, zero point two doesn’t begin to keep up with it, much less outpace it.